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Is a Roth IRA Better Than Whole Life Insurance?
Is a Roth IRA better than whole life insurance? The short answer is, in many cases, it may be better to have a whole life insurance policy, which offers a guaranteed payout no matter when you die. Let’s get into the details.
What is Whole Life Insurance?
Whole life insurance is the most popular form of permanent coverage, and for good reason. It offers guaranteed protection, level premiums, and a cash fund that accumulates value over time on a tax-deferred basis. The death benefit of a life insurance policy can also be used to create an immediate estate or to aid in estate planning, making it a versatile financial tool to plan for your own life and leave a legacy for your loved ones. So long as you make your premium payments, your insurer is contractually obligated to pay the full death benefit no matter when you die. Additionally, the money left behind through life insurance is not subject to probate or other legal red tape, making it a more straightforward and timely method of leaving money behind.
While it is more expensive than term coverage, each of your premium payments are split to cover the cost of insurance and to contribute to your cash value fund. The cash fund accrues compounded interest, and after several years of premium payments, you will be able to withdraw funds as a “self-loan” or withdrawals.
- If you withdraw less than what you’ve paid into the policy, you can just take the money and pay zero income tax.
- A loan allows you to borrow against the cash value of your policy. Like any loan, you will be charged interest until the loan is paid back. However, a loan against your cash value does not appear on or affect your credit score, so there's more freedom to pay it back over time. Be sure you consult your life insurance agent or financial advisor before taking out a loan to ensure it doesn't affect your policy's death benefit.
The Advantages of Whole Life's Cash Value
You can withdraw funds to afford higher education costs, supplement your retirement, afford medical bills, and more. If you want to grow your fund faster, you can even choose to pay more than your required premiums to add value. Unlike an IRA or other retirement funds, there are no limitations to how much you can contribute annually. In addition to the cash fund, when you pass away, your beneficiaries will receive a death benefit that is income tax-free.
The cash value of a whole life insurance policy is an asset that can be used during your lifetime. If some or all your cash fund goes unused, it may also be passed onto your heirs with the death benefit - this depends on the insurer and how they handle unused cash value. Some will pass it on, some will not, and some will only do so if you buy a rider (policy add-on) that specifies you want this to happen. /p>
What Is an IRA?
An individual retirement account (IRA) is an account used to save for retirement. The IRA is specifically designed for self-employed individuals who do not have access to workplace retirement accounts such as a 401(k). However, anyone with an earned income can open and contribute to an IRA, including those who already have a 401(k) account through an employer.
There are limitations on the total amount you can contribute to your retirement accounts in a single year. You can open an IRA through a bank, investment company, an online brokerage, or a personal broker. You typically cannot withdraw money from these accounts before reaching the age 59 ½ without incurring a large tax penalty of 10% of the amount withdrawn. There are some notable exceptions to this – educational expenses and first-time home purchases, among others. There are annual income limitations in place as well that apply to deduction contributions to traditional IRAs and contributing to Roth IRAs.
There are 4 types of IRA, each with different rules regarding eligibility, taxation, and withdrawals:
Traditional IRAs
With a traditional IRA, you can put pre-tax dollars into your retirement investment account to let it grow tax-deferred until you begin making retirement withdrawals at age 59 ½ or later. Custodians, including commercial banks or brokers, will invest the funds you deposit into different investment vehicles based on both your instructions and the offerings available. You can deduct your contributions from your income tax return, meaning the IRS will not apply income tax to the earnings deposited into your IRA. When that money is withdrawn down the road, your earnings will be taxed at your income tax rate at the time of retirement. If you expect to be at a lower tax bracket when you retire than what you’re at now, a traditional IRA may be recommended. If you have another retirement savings fund in place, such as a 401(k), the IRS may limit the amount of your traditional IRA contributions that can be deducted from your taxes.
There are required minimum distributions (RMDs) from traditional IRAs depending on your age and when you were born. You must begin taking distributions by April 1 of the year after you turn 70 ½, 72, or 73 depending on when your birthday falls. If you choose to withdraw funds prior to your full retirement eligibility, you will incur a 10% penalty of the amount withdrawn and taxes at standard income tax rates. However, there are several exceptions to these penalties.
Some of these exceptions include:
- The purchase or rebuilding of a first home for yourself or a qualified family member
- You become disabled
- To cover expenses to afford higher education
- Expenses incurred for having or adopting a child
- Paying for medical insurance after losing your job
- You are in the military and called to active duty for more than 179 days
- You use the assets for unreimbursed medical expenses
Roth IRAs
A Roth IRA is a much more flexible option than traditional, with some key differences. The biggest difference is that a Roth IRA account does not allow you to deduct your contributions from your income tax, but the qualified distributions are tax-free. Roth accounts use after-tax dollars, meaning you pay income tax before making any contributions. Your funds can be withdrawn at any time, penalty-free. However, your earnings are still subject to the 10% penalty if you choose to withdraw them before age 59 ½. As the account grows, you do not face any taxes on your investment gains. In addition, there are no required minimum distributions (RMDs). If you don’t need some or all the funds, you can keep it in your Roth IRA without facing penalties. You can even leave the money to your heirs if you don’t end up needing it. There are still limitations to how much you can contribute each year, as well as income limitations to qualify. This flexible option may not be available to you if you have a modified adjusted gross income (MAGI) that is too high. Contributions are gradually phased out as your MAGI increases, up to a certain value, in which case you cannot contribute to a Roth at all.
Simplified Employee Pension (SEP) IRAs
SIMPLE and SEP IRAs are both benefits that can be instituted by an employer. While they cannot be opened by an individual, they function similarly to a traditional IRA with higher contribution limits, and they may allow for company matching. SEP is a retirement plan that an employer or self-employed individual can open, where the employer is allowed a tax deduction for contributions made to the fund. The employer makes contributions to each eligible employee’s SEP-IRA on a discretionary basis, and those contributions are vested immediately.
Vesting is an incentive program for employees that gives them benefits, usually in the form of stock options, when they have fulfilled a specified term of employment with their company. The benefits can be other assets, such as retirement funds. Vesting is a way for employers to incentivize their top-performing employees to stay with that company, as a common vesting schedule is three to five years. When it refers to retirement plan benefits, vesting gives employees the rights to employer-provided assets over time, such as matching dollars in a retirement fund on an increasing scale. The employee must stay with the company long enough to be eligible to receive these benefits.
Savings Incentive Match Plan for Employees (SIMPLE) IRAs
Also instituted by an employer, SIMPLE IRAs are retirement savings plans that can be used by most small businesses with 100 or fewer employees. Employers can choose to make a 2% retirement account contribution to all employees or make an optional matching contribution of up to 3%. These IRAs have minimal paperwork requirements, and the employer establishes the plan through a financial institution that will administer it. The startup and maintenance costs are low, and employers get a tax deduction for contributions they make for employees. However, the drawback of using SIMPLE IRAs is that the business owner cannot save as much for retirement as they might with other small business retirement plans, and these accounts cannot be rolled over into a traditional IRA without a 2-year waiting period from the time the employee first joined a plan, unlike a 401(k).
Is a Roth IRA Better Than Whole Life Insurance?
As with any financial question, it depends on your needs and specific financial situation. If you do choose to use life insurance to help save for retirement, it is known as having a life insurance retirement plan (LIRP). A LIRP plan uses a permanent life insurance policy’s cash value fund to help fund your retirement. The cash value has similar tax advantages to a 401(k) or IRA, with the added benefit of a death benefit to leave behind when you die.
Let's take a look at a few specific comparison points.
Your Health. Roth IRAs do not consider your health when you open an account, while life insurance does. Whole life insurance does consider your health and age at the time of your application, so those who have preexisting health conditions or who apply later in life will have to pay higher premiums.
Income & Withdrawals. There is no income tax or withdrawal tax on your Roth fund because it grows using after-tax dollars (unless you want to access funds before age 59 1/2). However, there are limits on how much you can contribute annually. In 2022, the limit was up to $6,000 ($7,000 for those 50 and older). In addition, you can only use earned income that you’ve already paid income tax on. Also, if you make too much annually, you may not be able to open a Roth IRA fund. Whole life insurance, in contrast, has no restrictions on the type of income you can use to pay your premiums, and there are no annual limits on how much you can contribute. With whole life insurance, your money will grow tax-deferred, and your loved ones will receive a death benefit when you pass away. You will only be required to pay income tax on withdrawals from your cash value that exceed the amount you've paid into the policy (referred to as the "basis").
The biggest benefit of whole life insurance is that your death benefit is guaranteed. And with your whole life protection, it doesn’t matter when you die. If you pay your premiums, your beneficiaries will receive the full death benefit. It is a guaranteed return on your investment, whether you make one premium payment or one hundred before you die.
In the long run, whole life insurance may be a good option that rounds out your financial portfolio. If you're reaching your annual limitations on your retirement funds, you may choose to invest in whole life insurance instead. You can secure a death benefit and fund your cash value to prepare for retirement in replacement of or in addition to a Roth IRA. It may make more sense to purchase whole life coverage to save up for your retirement at the same time instead of funding a Roth IRA and paying premiums on a policy. If your modified adjusted gross income (MAGI) is too high to qualify for a Roth IRA, whole life insurance is a worthwhile alternative. Chances are, if your MAGI is too high to qualify for a Roth IRA, you will be in a position to contribute more than your required premiums to a whole life policy, allowing you to build up more savings for retirement. Whole life coverage may not be better than a Roth for retirement purposes if you cannot build up the cash value. However, whole life insurance may pay off more in the end, which may make it a better investment long term. The guaranteed payout for your loved ones and the growth of your cash fund can help secure your financial future all in one. It is important to consult your financial advisor when making decisions about your retirement savings plans.
Bottom Line
Securing your retirement can be confusing and stressful. If you're stuck between choosing a Roth IRA or whole life insurance to fund your retirement, why limit yourself to one? You'll be able to accumulate cash value as an asset for your lifetime, plus secure a death benefit for your loved ones to create an immediate estate. The tax benefits are similar, there is no limit to how much you can contribute, and the protection of a whole life insurance policy is guaranteed.
Want to learn more or get a quote? You can do so here on our website or give us a call at (800)521-7873. Let us help you secure your retirement today!
